For what seems to be the umpteenth occasion, Australian economic growth stunned financial markets in the first three months of 2016, increasing by an enormous 1.1% for the quarter in seasonally adjusted volume terms.
It left the year-on-year expansion at 3.1%, higher than the 2.9% pace of the previous quarter and expectations for a deceleration to 2.8%.
Not since the September quarter of 2012 has the economy expanded at such a pace.
It was a truly stunning result, extending Australia’s run without a technical recession — defined as two consecutive quarters of negative growth — to 99 quarters, second only to the Netherlands with 103 in terms of uninterrupted growth for a developed economy.
However, one look at drivers behind the enormous quarterly GDP increase raises questions over the sustainability of the result.
Net export contribution alone contributed a whopping 1.1 percentage points to headline GDP. Throw in persistence weakness in nominal GDP, measuring income rather than production, and it suggests that the economy may not be as strong as the headline figures would suggest.
Now that the report has come and gone, it’s time to see what economists have made of the release. Here’s just a few of the research notes that we’ve received so far, starting with two banks that correctly called the quarterly increase, the CBA and NAB.
Gareth Aird, CBA
While backward looking, today’s GDP data show that output growth has been remarkably solid in the face of a huge downturn in mining investment. Growth at a little above trend would normally be accompanied with a discussion around monetary policy tightening rather than loosening. But the composition of growth, coupled with incredibly weak wages pressures and falling inflation expectations mean that the RBA’s concerns about entrenched low inflation and disinflation risks will persist.
Nominal GDP, which is the broadest measure of income in the economy, and is effectively the tax base, grew by less than real GDP. Historically it’s a rare thing, but it has been a familiar outcome since September 2014. It is why the economy feels weaker than the output numbers imply. Income weakness weighs on both household and business confidence and also on inflation expectations. It also makes debt repayment harder, notwithstanding record low interest rates.
As such, we expect further monetary policy easing and have pencilled in two more rate cuts that would take the cash rate to just 1.25%.
Alan Oster, NAB
Consistent with the closing phases of the mining boom, a strong contribution from net exports – bolstered by commodity production – was largely offset by sharp declines in mining investment. Household consumption made a strong contribution, despite a rise in the household savings ratio, thanks to the apparent strength in services consumption. Government spending and dwelling investment also made more modest contributions to growth.
Price indicators in the National Accounts generally followed the very weak outcome seen in the Q1 CPI. The GDP deflator – the broadest measure of inflation – recorded a decline of 0.6% in the quarter, while the consumption deflator fell 0.1%.
The RBA is likely to look through the strong Q1 GDP result given it was largely due to a lift in exports that is not expected to be sustained in the medium term. Additionally, the subdued Q1 CPI figure means the RBA will also be focused on the national accounts measures related to prices, including wages, unit labour costs, and the consumer price deflator – which were also subdued.
At this stage, NAB expects the RBA to remain on hold for the remainder of 2016, though we do acknowledge a further rate cut remains a possibility if inflation continues to surprise to the low side.
Felicity Emmett, ANZ
Today’s data support the story of an ongoing transition to non-mining activity. The drag from falling mining investment is likely to be at or close to a peak and commodity prices look to have bottomed. Strong growth in resources exports, where new capacity is coming on stream, is helping to offset the weakness in mining investment. The services sector is also growing strongly, helped by a lower AUD, and consumer spending is being supported by strong gains in house prices. The activity side of the economy is playing out broadly as we and the RBA expected.
Inflation is the main game for the RBA at the moment, and today’s report shows ongoing soft price pressures in the economy. The average wage rate bounced 0.4% q/q following a 0.4% fall in Q4 and annual growth is now running at 1.2%, which, although still very low, is up from 0.5% in Q2 last year. While this is very tentative evidence that wage inflation may be bottoming, we continue to expect underlying inflation to remain below the Bank’s 2-3% target band until close to mid-2017.
For policy, today’s numbers highlight the dilemma the RBA is facing. On the one hand, activity and labour market data suggest the economy is strengthening. On the other hand, inflation remains very low. We continue to expect another cut in the cash rate of 25bp to 1.5% at the August board meeting
The March quarter National Accounts reveal that real activity surprised to the high side and confirmed disinflationary forces are impacting the Australian economy at present, as indicated by the Q1 CPI report.
The wage picture remains relatively soft, consistent with the picture from the Wage Price Index. Nominal average wages for non-farm employees grew by 0.4% in the quarter to be 1.2% higher over the year. That has real wages flat over the past year.
For the RBA, the real economy story is stronger than expected, with annual growth a little above trend and a fraction above 3.0%. However, the RBA’s focus is on weak inflation. On prices, the National Accounts did not provide any new information but rather confirmed the disinflationary picture evident in the Q1 CPI report. The household consumption deflator declined by 0.1% in the quarter, matching the fall in the seasonally adjusted headline CPI.
We continue to expect the RBA to respond to current inflation weakness with a follow-up rate cut in August.
Shane Oliver, AMP Capital Markets
Thanks to the export volume boom flowing from the final phase of the mining boom, along with the rebalancing of the economy away from mining investment to consumer spending and housing, Australia is continuing to avoid the recession that some have feared over the last few years. This is likely to remain the case and is very good news.
However, the challenge is that surging resource export volumes will not be a big jobs generator and nominal growth in the economy remains very weak. Nominal GDP only rose 2.1% over the last year to the March quarter as export prices plunged and domestic inflation weakened. The weakness in nominal growth is showing up in weak profits and of course weak tax revenue going to Canberra.
The contradiction between strength in conventional volume based GDP and weak nominal growth presents a conundrum for the RBA. However, we continue to see the downside risks to inflation ultimately driving lower interest rates from the RBA with next move likely to be in August.
Scott Haslem, UBS
Exports remain a key driver, with net exports adding 1.9 percentage points to Australia’s 3.1% y/y growth. This leaves the domestic economy running a more modest 0.9% y/y in Q1 16, led by a resilient consumer, still firm housing and a recovering public sector, which is more than offsetting the worst capex drag since the 1990’s recession.
Reflecting the mining export contribution to Q1 growth, non-mining GDP eased to 2.4% y/y, while by state, demand strengthened in NSW (+1% q/q, 4% y/y), fell sharply again in WA (-1% & -4%), and was mostly flat q/q elsewhere.
The weakness in the nominal economy, including profits & wages, remains the key caution, albeit the recent steadier commodity price environment may be flagging that this drag may soon ease. Today’s GDP data adds to the upside risk already in our 2016 year-average GDP forecast of 2.5%, and challenges those looking for the RBA to cut the cash rate to 1.0%.
Paul Bloxham, HSBC
Real GDP growth has been strong, but this has been led by strong growth in exports, while domestic demand and local income growth have been weak. At the same time, because domestic demand is still running below trend and income growth has been weak, inflation has fallen.
There are a number of different ways to think about this.
First, Australia’s economy is doing very well, considering the circumstances. In the face of a massive decline in commodity prices and mining investment, growth is rebalancing towards housing construction and the services sectors, led by exports of tourism, education and business services. GDP growth is also being supported by a ramp up in resources exports, as much of the capacity that was built during the mining investment boom is now coming on-line.
Second, falling commodity prices have led to lower national income growth but slower growth in wage and prices have helped the economy to adjust. Wages growth has slowed substantially and if it had not, fewer jobs would have been created. Lower inflation is largely the result of slower growth in wages. In short, lower wages and inflation are part of the adjustment mechanism in the face of end of the mining boom.
Third, lower inflation and wages growth, as an indirect result of the fall in commodity prices, have allowed the RBA to cut its cash rate further, which itself, is assisting the rebalancing of growth.
Our view is that the RBA will probably cut its cash rate by a further 25bp to 1.50% in August, following the Q2 CPI print and then hold steady at 1.50% in subsequent quarters.
Chris Caton, BT Financial Group
Today’s GDP release was both strong and stronger than expected. One can quibble, of course, with the composition of growth. A massive amount of it came from net exports (more so in real terms than in nominal terms) but consumer spending and residential construction also contributed. The missing guest at the growth party is still non-mining capital spending.
It is sometimes useful to “highest since” or “lowest since” components. The fall in the GNE deflator for the first time this century is one more piece of evidence (after the CPI) that disinflationary pressures may be becoming entrenched.
Although the “cockroach” theory suggests that rate cuts are rarely solitary, the solid growth shown today, along with the building approvals data yesterday, and the continued firmness of house prices may cause the RBA to wait for more evidence before cutting again. If it happens, it is now far more likely to be August rather than June.
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